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SK Telecom Fixed at Neutral

SKM AAPL

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We are maintaining our long-term Neutral rating onthe leading South Korean telecom operator SK Telecom Corp Ltd (SKM - Analyst Report) following its third quarter results. Despite the strong smartphone adoption, third quarter net income dropped because of higher investments.

SK Telecom continues to invest heavily to upgrade its network and expand its 3G and 4G networks to take advantage of the growing popularity of its smartphones. SK Telecom plans to invest KRW 1 trillion ($890 million) over three years (2011-2013) in smartphone services and mobile software business (i.e. to upgrade Facebook, Google Inc. Maps and Apple Inc. (AAPL - Analyst Report) iTunes in handsets). This will further boost SK Telecom’s presence in the software sector and drive smartphone sales. The investments augur well for the company’s future growth.

While the company’s aggressive smartphone strategy open doors in the wireless data business, associated promotional expenses and heavy handset subsidies may drag its earnings in the near future. Additionally, wireless competition is at its peak in the South Korean mobile market.

Despite the surging demand for smartphones, even Apple iPhones are struggling with sales stagnation in the saturated domestic market. Further, we remain cautious on tariff reductions that are hurting revenues, intense competition and heavy regulation by the Korean ministry.

Nevertheless, SK Telecom continues to rule the Korean wireless market, thanks to its diverse offerings. We believe strong smartphone penetration, 3G network, advanced 4G Long Term Evolution expansions and the cloud computing business will fuel growth at SK Telecom.

Moreover, the companyis poised to benefit from the growing Wi-Fi and data femtocell service. SK Telecom is expected to increase the Wi-Fi zones to 62,000 by deploying additional 45,000 Wi-Fi zones by this year-end as well as by expanding femtocells to 10,000 from 1,000 last year.

Over the long term, SK Telecom intends to enter new businesses such as education, health care and distribution. Further, SK Telecom is seeing growth opportunities in the chip market and spreading its fixed-line and wireless businesses globally through its largest proposed acquisition.

The company has agreed to buy a 21% stake in the second largest chipmaker, Hynix Semiconductor Inc. for KRW 3.427 trillion ($3.04 billion). The terms of the deal are yet to be finalized as SK Telecom plans to conduct due diligence in December. The deal is expected to be completed by the first quarter of next year.

Hence, the stock retains the Zacks #3 Rank (Hold) for the short term (1-3 months).

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